Archive for Business Succession Planning
SOME BASICS OF BUSINESS SUCCESSION PLANNING
More than eighty percent (80%) of businesses in the U.S. are private or family dominated. Yet, these closely held businesses have an extraordinary failure rate. Seventy percent (70%) do not survive to the second generation. Eight-five percent (85%) do not survive to the third generation. The average family owned business lasts only twenty-four (24) years.
Why do so many businesses fail after the first generation? Primarily because the majority of business owners do not have either a formal business succession plan or comprehensive estate plan. A business succession plan must be part of the business owner’s overall estate plan. The four (4) leading causes for failure of family owned businesses are: inadequate estate planning; failure to properly prepare and provide for the transition for the next generation; lack of funds to pay estate taxes; and conflicts with family members not actively involved in the business.
There are many ways to guard against such failure. This article will highlight the following five (5) techniques for business succession planning: Buy/Sell Agreement; Family Limited Partnership; S. Corp. Recapitalization; Employee Stock Ownership Plan; and Intentionally Defective Grantor Trusts.
A “Buy/Sell Agreement” is an agreement among the Company and shareholders to buy stock from shareholders upon certain events, such as, disability, death, divorce, or retirement. Key components of a Buy/Sell Agreement include properly valuing the business and providing for funding of the agreement, usually by an insurance policy taken out against the shareholder’s life.
A family limited partnership strategy works well when a business owner has family who will continue in the business and the business is valued at $5,000,000.00 or above.
One of the most frequent types of business ownership for closely held interests is an S. Corp. Unfortunately, due to the ownership restrictions of S. Corp., many business succession strategies are not available to S. Corp. owners. There is, however, one strategy known as “S. Corp. Recapitalization” which is available. This technique is typically used when the owner has family who will stay involved in the business.
An Employee Stock Ownership Plan (ESOP) allows owners of closely held companies to sell to an ESOP and reinvest the sales proceeds on a tax deferred basis, providing the ESOP owns at least thirty percent (30%) of the company and certain other rules are met. The company establishing the ESOP must be a C. Corp, not an S. Corp. This technique provides liquidity for the retiring shareholder and also provides motivation for employees to continue the company as owners. Use of this technique requires that there are key individuals who are willing and able to continue the business after the current owners have sold or retired. ESOPs are effective, but are subject to many rules and regulations and should be considered only after a thorough examination of all factors involved.
With an Intentionally Defective Grantor Trust (IDGT), the owner sells shares of stock in the company to an irrevocable trust in exchange for a small cash down payment and a long term installment note. This freezes both the value of the asset and the return on that asset (and reduces the size of the grantor’s estate.) The trust is intentionally drafted so that the creator is treated as the owner for income tax purposes. By paying the income tax on trust income, the grantor effectively makes additional gift tax free transfers to the beneficiaries. Children of the owner are usually the beneficiaries of this type of trust. A major concern with this technique is whether there will be sufficient cash flow to play the installment obligation.
In summary, there are a number of techniques available to minimize estate tax exposure while achieving a business owner’s wishes to transfer and continue the business which he or she has built. Whichever technique is used, it should be part of a comprehensive financial and estate plan. The attorneys at Cramer Law Center are available to assist with that planning. Remember, history has shown that having a good estate plan does not accelerate the date of death.